Question

The money multiplier equals:________.

Answer 1

Answer: B. 1/R, where R represents the reserve ratio for all banks in the economy.

Explanation:

The Money Multiplier is the money that Banks generate given a certain RESERVE REQUIREMENT/RATIO.

A Reserve Requirement is money that the Central Bank requires that Banks do not loan out and instead keep in reserve.

For example, if the reserve rate is 10% and a bank has $10 they can only loan out $9.

Assuming they loan out $9 then they created $19 in the economy because their customers still own the original $10 but now they have also given loans of $9. The people who take the loans then deposit it in another bank. That bank would keep $0.90 in reserve and loan out $8.10 meaning that $27.10 now exists in the economy.

The process goes on and on until it gets to $100.

A simpler way to get to the final figure is to divide 1 by the reserve requirement = 1/r which is the money multiplier.

Using the above example, that would be 1/0.1 which is 10.

Multiplying this 10 by the initial deposit of $10 will give you that same $100.

Answer 2

Answer:

B. 1/R, where R represents the reserve ratio for all banks in the economy.

Explanation:

Money multiplier is a term used to relate the maximum amount of commercial bank money that can be created, given a certain amount of central bank money.

Money multiplier simply tells you about the maximum amount of money supply that could be increased based on an increase in reserves within the banking system.

By simple terms,

The formula for the money multiplier = 1/r

where, r = the reserve ratio.